Turn Down a Good Takeover Bid, Get Punished

Feb. 4, 2016

By Lisa Litzinger-Drayton

In 2008, Microsoft attempted to takeover Yahoo! Inc. The company’s first public bid, valued at approximately $47 billion, represented more than a 60 percent premium over Yahoo’s pre-bid stock price. Yahoo executives rebuffed this offer, suggesting that it undervalued the firm’s strategic opportunities.

Facing a hostile proxy fight, Microsoft increased its offer by 14 percent, but this bid was also rejected. Microsoft then rescinded the offer.

A recent research paper co-authored by Drexel LeBow’s David Becher, associate professor of finance, analyzes what happens when organizations such as Yahoo! resist “good” takeover bids. They also look at what happens when firms turn down bad bids.

“Sometimes, an offer is rejected because it’s a bad deal. But oftentimes, companies turn down a good deal – probably because the target is entrenched,” Becher explains. “Which is why we pay CEOs with stocks – to incentivize them to make the best decisions for shareholders.”

Becher and his co-author began by determining how much is enough to qualify as a “good offer.” The average premium, they found, of a good offer was 40 percent over current stock price – give or take depending on factors such as industry, company size, performance/profitability, economic climate, etc.

They came up with a measure they call abnormal premium –- a “positive abnormal premium” is an offer above what a company should expect to get, and a “negative abnormal premium” is an offer that’s below it.

The researchers then evaluated thousands of recent takeover bids that did not go through. “We looked at what happened to firms that turned down offers for mergers – broken down by offers that were more, or less, than expected – and what happened next,” Becher says. “What we find is firms that turn down good offers tend to be punished. They are more likely to eventually go out of business or be delisted from the stock exchange. The CEO is more likely to be pushed out, and they tend to do worse, fiscally.”

Specifically, the numbers show that when firms turn down deals where they were offered positive abnormal premiums, they are 10 percentage points less likely to be around three years later. On a relative basis, they are nearly three times more likely to be delisted or liquidated than firms with negative abnormal premiums. Furthermore, CEOs that turn down deals offering a positive abnormal premium are two-and-a-half times more likely to be forced out versus CEOs that reject negative abnormal offers.

There are plenty of examples on the other side as well. In the middle of the recent recession, Exelon bid for NRG, claiming their offer of a 40 percent premium was a great deal. “In this particular case, where the stock price was at a rather low point for NRG, the 40 percent premium was not a great deal. NRG said no. Its stock price went up. Exelon continued to try to force the deal. They even ended up buying enough shares to own NRG, but still could not convince the company to accept the takeover,” Becher explains.

“It was a bad deal for the shareholders, and they turned it down because they knew it. And the stock price continued to climb.”

This research can help firms to better understand what they should expect from a good takeover bid – as well as provide examples of what can happen when good bids are turned down. “If you offer more than the market expects, they should say yes. Or, they are more likely to be punished.”

Becher says the Yahoo example highlights the substantial complexity in evaluating the objectives and efficacy of target managers engaged in publicly negotiated takeovers. “This is a classic example of the market punishing a company for turning down a good bid.” The bid’s withdrawal coincided with a 15 percent reduction in Yahoo’s market value — drawing the ire of shareholders. Pointed criticism was directed at the negotiating skills of then Yahoo CEO Jerry Yang.

In the years following the rejection of the Microsoft attempt at takeover, Yang, who founded he company, was fired from the CEO position, then kicked off the board too. The company has staggered from CEO to CEO, and, Becher says, there is now talk about the possibility of breaking it up.

The paper “Bid Resistance by Takeover Targets: Managerial Bargaining or Bad Faith?” co-authored by Drexel LeBow’s David A. Becher, associate professor of finance and a Center for Corporate Reputation Management fellow, is forthcoming in the Journal of Financial and Quantitative Analysis.